TESTIMONY OF
RICHARD BLUMENTHAL
ATTORNEY GENERAL OF THE STATE OF CONNECTICUT
BEFORE THE SECURITIES EXCHANGE COISIMISSION
SEPTEMBER 20, 2000

I appreciate the opportunity to speak and the extraordinary leadership and
courage of Chaimman
Arthur Leavitt in proposing and advocating the Commission's proposed regulations
governing
the independence of the accounting profession. In particular, these measures
restrict the ability
of public accounting firms to conduct audits of companies with which the
accounting firms have
consulting contracts for services such as bookkeeping, financial system
information systems
design, actuarial services and human resources management. I strongly support
this proposal.

Public accounting firms have a special duty to ensure the accuracy of financial
information about n
corporations that the public trusts when investing. Never before has this
special duty been so
important. More people today are investing more money in public corporations
than ever before.
Recent figures from the Investment Company Institute indicate that more than 88
million people
have a stake in the stock market. Retirement savings or college education, along
with everyday
needs, may hinge on the trustworthiness of information that underlies
investments.
Investors depend on the work performed by "independent auditors" in making their
investment
decisions and rely on the representation that the auditing work is truly
independent. As the SLC
has correctly noted, the profound and fundamental changes in the business
activities of major I
accounting-consulting firms have seriously eroded the concept of an
"independent" auditor.
When the auditor's firm is financially dependent on the consulting business it
receives from the
companies it audits, the auditing firm becomes in a very real sense a captive of
the audited
company It becomes beholden to it and dependent on it. The tough-minded
questions and
Vigorous standards that the public has traditionally associated with the term
"independent
auditor" have been compromised by the interdependent business relationship
between the
auditors and the audited. Truth in advertising would demand that for many large
consulting-consulting firms the term "independent auditor" be replaced with the
term "company
accountant."
Regulations adopted by the American Institute of Certified Public Accountants
(AICPA) and the
Securities Exchange Commission (SEC) have failed to preserve the independence of
public
accountants.

Indeed, during the past 25 years, management and financial consulting revenues
at public accounting firms have grown from 12 % to 70% of total revenues. This
booming sideline business is extremely profitable. Yet, the regulations
currently allow public accounting firms to audit companies from whom they gain
significant profit through consulting contracts. In fact, engagement partners
are encouraged to market consultant contracts to firms that they are auditing.

Will those contract profits compromise the independence of the public
accountant? Can a public accountant in that situation say no to a company that
seeks to bend accounting rules to overstate earnings? When asked, 94% of stock
analysts believed that significant consultant fees are likely to compromise
audit independence.

Connecticut residents have personally experienced the financial hardship
occasioned by the loss of independence and objectivity in the accounting
profession. In the Colonial Realty real estate investment scandal that rocked
Connecticut in the early 1990's, interdependent relationships between the
Colonial Realty Company and its auditors Arthur Andersen & Company became a
primary factor in the loss of hundreds of millions of investor dollars. My of
office's investigation of the accounting work done by Arthur Andersen for Colonial
Realty directly demonstrated the need for independence between auditors and the
companies they audit. As detailed in our 1993 report, the most obvious
compromising relationship between Arthur Andersen and Colonial Realty was the
family relationship between the head of Andersen's Tax Department and one of
Colonial Realty's General Partners. While not a "bloodline" relationship, the
intermarriage of the Andersen and Colonial partners certainly symbolized the
intermarriage between the accounting firm and its client. Other obvious
independence issues involved gifts and loans by Colonial Realty to Andersen
partners and staff

More subtle and more insidious, I believe, was the fact that Colonial Realty was
an important client of Andersen, generating millions of dollars in fees for the
accounting-consulting firm. In the final analysis, Arthur Andersen was not
objective or independent in the accounting work it did for its client the
Colonial Realty Company. Its examinations of the financial forecasts for
Colonial's real estate deals were fatally flawed. There were no reasonable bases
for the financially favorable conclusions Andersen reached. In fact, as part of
its review of Colonial's financial forecasts for prospective investors, Andersen
accountants reviewed the financial information that they themselves had prepared
for Colonial Realty prior to Colonial's decision to purchase the investment
property. Nevertheless, the aura of independence and objectivity which Andersen
brought to its audits of Colonial Realty induced thousands of investors to hard
over their savings over to Colonial Realty -- hard-earned savings they would
never see again.

The result of this investigation was the largest penalty on a public accounting
firm in Connecticut history -- $3.5 million -- which included payment to
Colonial Realty's investors of the $2.5 million in fees Andersen had received
from Colonial Realty for its accounting and consulting work. In addition,
private litigation based on our investigation followed the release of the
report. While investors eventually recovered a portion of their losses, many
surely never recovered their faith in such investments or the accounting
profession.

The highest standard of independence should be demanded -- avoiding this kind of
real abuse and eliminating also the appearance of impropriety.

I support the proposed SEC regulation to further restrict the types of
consultant contracts an accounting firm may have with a corporation that it is
auditing. Indeed, I would seriously consider broader restrictions, which the SEC
has under review, to prohibit audits of corporations when the accounting firm
has any significant fee generating contract with such corporation. While certain
types of contracts such as financial reporting and quality control consulting
can generate a perception of compromised audits, there is a point where the sum
of all forms of contractual relationships is so significant as to create a
perceived, if not real, conflict of interest.

As Attorney General in Connecticut, I have aggressively fought for the interests
of consumers, seeking legislation to require greater disclosure of information
to consumers and to provide the ability to seek court restitution for damages as
a result of fraud. The cornerstone of our consumer protection laws is the
Connecticut Unfair Trade Practices Act, which prohibits unfair or deceptive acts
or practices. At some point, audits of corporations with whom the public
accounting firm has substantial consultant contracts could raise the question of
whether it is appropriate for such firms to use the word "public" accountant.

I intend to speak with my colleagues in state attorneys general offices across
the nation about this proposal and urge their support. As consumer advocates, I
am certain that they will share the Commission's concern for protecting the
integrity of the financial reporting upon which many consumers are dependent for
investing their hard-earned dollars in order to ensure a secure future.

Reform is needed. The Colonial Realty scandal was only small potatoes compared
to the type of work currently being performed by this nation's so called
independent auditors. The Commission's rules should be tightened and clarified,
not to make accounting and consulting work easier to obtain, but to protect the
public interest and public trust, and the credibility and integrity of the
institutions at stake.